Maryland Corporate Income Taxability and Intercompany Transactions

This summary was prepared by Karen T. Syrylo, CPA for the Maryland Chamber.

This week, the Maryland Court of Appeals issued its decision in Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury; and Future Value, Inc. v. Comptroller of the Treasury (See the decision). Using Due Process and Commerce Clause analyses, the Court held that two subsidiaries that operated in Delaware and that did business with their Delaware based parent company that has some of its manufacturing operations in Maryland, were subject to tax in Maryland because the subsidiaries were corporations that did “not have economic substance as separate business entities.”

A patent company, Gore Enterprise Holdings, owned and managed patents and licensed patents to the parent company in return for a license fee; a financial subsidiary, Future Value, held and managed the Gore corporate group’s excess capital and made loans to the parent and charged interest on the loans; all transactions were at fair market value rates. Seemingly important to the judges’ view of taxability was their statement that “the parent’s activity is what generates the subsidiary’s income.” That the subsidiaries also had activities with unrelated third parties did not change the Court’s analysis.

The Court also upheld the Comptroller’s apportionment formula used to calculate the portion of the two subsidiaries’ income that is taxable in Maryland, which is different than the formula contained in current regulations for intangible income such as patent royalty fees and interest. The decision refers to the Comptroller’s general power under Maryland law to alter the statutory apportionment method in order “to reflect clearly the income allocable to Maryland.”

Lastly, and importantly, the decision does clarify that the State cannot use the unitary business principle to determine that a company has enough contact with the state, nexus, to be taxable in Maryland. The unitary business principle (which involves complex definitions around the question of how related are multiple business components) applies to apportionment, i.e., how much of the total income is taxable in the state once nexus has been determined. The Court stated rather clearly that being unitary “does not confer nexus to allow a state to directly tax a subsidiary based on the fact that the parent company is taxable and that the parent and subsidiary are unitary.”

But alas, even with winning the battle over the Comptroller’s use of unitary to determine nexus, the taxpayer here has lost the war and owes the tax under the Court’s Constitutional analysis. And back to the point of “economic substance,” the Court made the concerning statement that “there is no reason – based either in case law or logic – for holding that the factors that indicate a unitary business cannot also be relevant in determining whether subsidiaries have no real economic substance as separate business entities.” Finding “real economic substance as separate business entities” in other taxpayers’ facts will continue to be a topic of discussion as there are other cases and audits in process. Stay tuned for whether the companies will appeal to the U.S. Supreme Court and for additional Maryland litigation.